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Sunday, December 19, 2010

Someone asked me what my formula is when calculating the profitability of a rental property, so I thought I’d post it!!

But before I do that, I just want to take a minute to disclaim that there are multiple formulas you can use effectively.

And honestly? It’s probably best if you figure out your own to fit your investment model or partner with someone like myself that really knows what they are doing.

The very first thing you should do before buying a rental property is visit other rental properties in your area to determine what the competition typically charges for rent. This is also great for one uping your investor competition, If your properties have better fit and feel they will rent before any of the others. Note: Dress down and do not drive your luxury vehicle when viewing the properties.

"To do this, I’ll usually pose as a tenant looking for a new place to live and take a few tours of different homes." Then, I’ll check back periodically to see how long it took for the home to be rented.

For example, if I find a 3 bedroom home for rent for $1400 a month and it took 2 months for the landlord to get it rented, I will assume the rent is slightly higher than it should be.

After all, a 2 month vacancy can kill your profits for the year. I prefer to keep my rent low enough that I can re-rent it in 2 weeks. One month, tops.

OK, so you’ve done the footwork and found that you can rent a 3 bedroom house with air conditioning and a dishwasher (Remember to keep your amenities comparable to other properties in your area!) for around $1200 a month.

You will need to plan your budget per month to cover:

1. The mortgage (Pay Cash or Partner with fund that can if at all possible)
*** Remember: I buy and Renovate homes to brand new for around $65k / so cash partners collect straight profits from day one of rented unit, not to mention a boatload of equity.

2. Your taxes

3. Your insurance

4. Maintenance costs (How much I put aside for maintenance every month depends on the age of the property. For example, if the property is fairly new and won’t need any serious repairs for a few years, I’ll only put aside $30 per month. If it’s an old property, maybe I’ll decide on $70. But no matter what, put aside something every month. After all, eventually you’ll need to replace the roof, the furnace, etc, someday and you don’t want the cost of that coming out of your profits. Also, it’s good to have some extra money put aside in case you end up with a problem tenant who trashes the place. On average, I put aside $50 per month per unit.)

5. Utilities, if you elect to pay them. (I usually don’t elect to pay the utilities)

6. Vacancy (I generally plan on a 1-2 month vacancy per Home, per year. If I luck out and no one moves out that year or if the empty home gets rented quicker, I consider it gravy.)

7. Your profit

As far as profit goes, I minimally need to make $800 per unit in straight profit. So if it’s a single family property, I would have to be able to pay all my bills and still pocket $800 a month. With a duplex, I’ve got to make $1600 a month right off the bat. A four unit apartment building would have to generate $2400 a month for me. And so on and so forth.

This might not seem like a lot of money at first… (that's me being sarcastic)especially when you consider the time and effort it will take you to find the right home, renovate it completely and then rent it.

You’ll rack up minor expenses simply by placing ads in the newspaper, placing signs in the yard and on corners around the neighborhood or just using gas to head to the home periodically to show it to potential tenants.

Service Calls / Property Management:Also, you’ll have to answer service calls (sometimes in the middle of the night) should something break, lawn upkeep, shoveling snow. A lot of people consider these things and ultimately decide owning rental property isn’t for them. ** Again This is why you want a partner like me that has the management company internally and in place.

Nevertheless, here are the other things you need to make sure you remember:

1. Tax write offs. I do not factor in how much I get back in taxes into my monthly profit. I consider it all gravy. Still, it’s nothing to sneeze at. *Also keep mind that any repairs you make to the property can be written off as well. "So I will scream this for the cheap seats, just in case you are not getting the point of making sure I am your partner, or you invest in my properties... We own my homes for an average of 65K, we get to write off an average of $50k per house the first year just in renovations!"

2. As the years go buy, you will eventually be able to charge more and more for rent. However, your monthly expenses will generally remain the same. The longer you own a property, the more your profit will increase.

3. At the end of the day, you own a property that generates a steady cash flow. Not only that, but it will have likely increased in value substantially. Hello, easy retirement fund!

4. $800 per unit is what I want to make minimally. Generally, I end up making more.

So back to our single family property that will generate a rent of $800 a month….

For the sake of easy math, let’s just decide to leave the utilities up to our tenant. In my area, taxes and insurance on a single family property will run around $180 per month. We’ll say the property is in great condition (just renovated), so we’ll only be putting aside $30 per month for maintenance costs. A one month vacancy per year will cost us about $100 a month. That gives us a total of $310 for expenses. Add on the $800 a month profit and we’re looking at $1110.

Also consider that single family homes usually generate the least amount of profit. Duplexes and apartment buildings will get you more cash for your buck. However, single family homes are easier to get rid of should you decide the money you’re making isn’t worth it. It’s much harder to dump an apartment building.

I recommend beginning investors start off buying a single family home for their first investment property "preferably one of my properties or system". If, for no other reason, than to ‘try out’ being a landlord.

To be a successful landlord you’ve got to be a good judge of character and have a low tolerance for bullshit. "This is why I prefer you buy my properties and use my management company"

For example, if you’re the type to always give people a break, you may just end up with tenants who don’t pay rent for months at a time. You’ve got to be willing to be the bad guy. You’ll have tenants who will call you up with all sorts of sob stories about sick children and lost jobs and you’ve got to be able to say, “Too bad. I still need the rent.” If your personality is such that you’re unable to be a real prick when the situation requires, then you’ll find this out when you’ve only got a small, easy to sell building that can be dumped fairly quickly.

Of course, if you find that you have no problems whatsoever being an asshole from time to time, you can always start looking at duplexes and apartment buildings then. Once you’ve perfected your personal system, you can start making some really tremendous cash flow providing something that everyone will always need " A roof over there head".

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Entrepenuer and Executive that is starting his business career outside of corporate america and looking for like minded individuals interested in making money in Real Estate while giving back to the communities we invest in.